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Greater emphasis needed on diversified growth funds in DC strategies, says BNY Mellon

Now is the time for greater emphasis on the role of diversified growth funds (DGFs) in an overall defined contribution (DC) strategy, according to a report from BNY Mellon Investment Management.

The report suggests that DGFs should play an increasingly important role in DC portfolios, not simply as a token shift away from equities, but as a suitable diversified approach that could help trustees protect members’ savings whilst offering real levels of growth in a disciplined, risk-aware manner.
 
Members are continually faced with challenging market conditions and extracting the benefits of diversification particularly in periods of extreme market stress, when correlations between traditional asset classes break down, requires a sophisticated and dynamically-managed asset allocation approach; DGFs can offer this.
 
“No longer should diversification simply be seen as a free lunch in investing. Extracting the benefits of diversification increasingly involves more sophisticated processes to capture the upside when markets are rising and avoiding the downside when they are falling or stressed,” says Catherine Doyle, head of defined contribution, UK at BNY Mellon Investment Management.
 
In turn, this solution helps members experience a smoother journey to retirement by providing the flexibility of achieving diversification throughout the lifecycle, progressing from the growth phase into the pre-retirement phase with the possibility of remaining invested “through” retirement into the decumulation phase.
 
“This gives members more control over the timing of their investment and their redemption date, assisting them in getting better outcomes from their retirement savings” says Doyle.
 
BNY Mellon maintains the various phases of the retirement lifecycle should be considered as a single journey with the flexibility to accommodate shifting retirement targets. Mechanical glide paths in lifestyle solutions, which have been typically prevalent in the UK, do not adequately perform in a range of market conditions and full market cycles.
 
The BNY Mellon paper considers the replacement ratios achieved by a hypothetical 55-year old worker who has amassed a multiple of their annual salary in a DC scheme and is soon to retire on their 65th birthday. A pertinent consideration involves the choice of investment vehicle in this timeframe. The simulation contrasts three investment strategies: the first a buy and hold balanced strategy, the second a lifestyle strategy following a linear glidepath and reducing the equity exposure to zero at retirement and the third with an allocation to a fund “kicker” on the outperformance of a specified target.
 
The evidence shows that a more target-driven “derisking” mechanism that follows a less mechanical glide path can produce better wealth outcomes, and the inclusion of a DGF strategy in material quantity, achieves the best risk-reward trade-off for typical investors.

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